Tax Cuts for Trickle Down
It is perhaps time to accept that Sri Lanka’s inability to manage economic crises brought on by the pandemic and its vulnerability to these externalities most certainly flow from the incoherence of “Vistas of Prosperity” as a policy document. The foreign exchange shortage and accompanying volatility are directly linked to the deteriorating external credit profile of Sri Lanka’s Treasury. The root cause was a drastic reduction in Government revenue projections caused by the Pohottuwa tax cuts that came as an overnight shock to international market participants. Proposed large-scale development signaling the intent for fresh borrowings was adequate justification for downgrading by ratings agencies.
“The CBSL provided concessionary funds to large corporates including those that reduced executive pay as soon as the initial lockdowns of April 2020 were announced. Meanwhile, corporate taxes are currently amongst the lowest in the South East Asian region at 14%-18%”
‘Gotanomics’ proposes a switch to a more market-oriented economy. Supply side policies; loosening regulations and lower taxes suggest that these policies aim for that illusive ‘trickle down’ phenomenon. American Venture Capitalist Nick Hanauer contends that “businesses do not create jobs” underlying the fallacy that “if taxes on the rich go up, job creation will go down”. Hanauer states that “jobs are created by a feedback loop between customers and businesses set in motion by consumers increasing their demand”. An LSE report from December 2020 reiterated the same point: “Major reforms reducing taxes on the rich lead to higher income inequality but do not have any significant effect on economic growth or unemployment”.
The structural flaws embedded in the economy seem to have been exacerbated by the ‘trickle down’ premise of the Gotabaya tax cuts; the burdens of which have fallen squarely on the poorest in the country while businesses have thrived. The latter seems a product-by-design of the SLPP 2021 budget, described by the Ceylon Chamber of Commerce (CCC) as ‘business-friendly, production-oriented and demonstrative of policy continuity’.
Prof. W.A. Wijewardena describes the 2021 budget as “a reversion to J.R. Jayawardene (JR) policies of the 1940s”. JR was infact an ardent Keynesian during his early years and a policy document presented by him to the Ceylon National Congress in 1939, provide some fascinating insights. As per JR, government spending would drive demand and state borrowings would fuel deficits. Prof. WA Wijewardena notes JR’s recognition that “it was the easy and quick way for an undeveloped country to become a developed country. In this model, state control of the economy at every level was the pre-requirement. And JR had absorbed that into his system faithfully”.
In his conclusion Prof. Wijewardana contends that the pandemic created an economic slump and that the space for raising taxes is limited. A point of contention here is that the economic slump was clearly exacerbated by supply-side policies which reduced government revenue and in turn led the country into a solvency crisis. As the government had already set in motion a program for further state expansion, its own policies compromised access to international finance.This further necessitated the implementation of its own version of Modern Monetary Theory (MMT). Despite several proclamations to the contrary, MMT must certainly create pressures on inflation, exchange rates and inevitably, food prices; these consequences were anticipated yet policy was ill-prepared.The proposals of 1939 were largely implemented post-independence by JR himself, policies that had a distinctly egalitarian blend with an emphasis on the poorest of Ceylon.
Two Sides of JR Coin
During this period, JR proposed state control over (1) production and distribution of agricultural produce (2) acquisition of land and (3) key heavy industries including iron and steel, fertilizer, transport etc. To protect the Sri Lankan worker, JR proposed a ban on foreign workers while suggesting that the state provide tertiary education and vocational training. JR had criticized the colonial policies that revolved around balancing the budget, as per Prof. Wijewardena, “his criticism was that when the country had adopted balanced budgeting, all programs for social and economic development have to be abandoned if there were no funding sources. It was unfair by an emerging newly independent nation which had a lot aspirations to become a nation of worth”.
“Economist and author Ronald J. Herring’s 1987 report titled “Economic Liberalization Policies in Sri Lanka” encapsulates two distinct periods of its economic history. The first begins in 1948, whereby increased State intervention was utilized as the solution to economic challenges and the second, where this intervention was viewed as a contributor to these challenges”
A 1975 CBSL report reviews economic policy since independence and references the profitability of the rubber industry during the ‘Korean Boom’ of the 1950s which significantly increased foreign exchange inflows. In its aftermath, continued economic stability was based on running manageable and minimal deficits. State revenue at the time was spent on education and healthcare but also on the rice subsidy, which averaged around 22% of government expenditure. Yet as the CBSL report notes, trade liberalization policies of that period, which continued after the end of the Korean Boom “tended to greatly reduce private investment in non-traditional undertakings”. A six year ‘program of investment’ was launched in 1954, the country’s first long-term economic development plan that emphasized the rural sector and invited foreign capital to supplement local capital to expedite the development of industry. There were strict limitations on the repatriation of capital and dividends while requiring local participation on equal terms.
The influence of J.R. Jayawardena on the economy would only grow in the decades there after. Economist and author Ronald J. Herring’s 1987 report titled “Economic Liberalization Policies in Sri Lanka” encapsulates two distinct periods of its economic history. The first begins in 1948, whereby increased State intervention was utilized as the solution to economic challenges and the second, where this intervention was viewed as a contributor to these challenges. Herring describes the period leading up to 1977 as an “expansion of the functional scope of government in the economy… resulting in a very heavily taxed, tightly regulated system”.
Fetish of Liberalization
The early literature from development research suggests that Sri Lanka was an example for the connection between ‘premature welfarism’ and stunted growth. In 1948, half the staple food (rice) requirement was imported and yet Ceylon also adopted a number of social welfare policies that were disproportionate to its per capita income. It was a classic case of diverting resources away from investment and into social consumption. In the 1970s however, the World Bank along with other developmental organizations began to shift their emphasis away from aggregate growth towards alternative criteria. It was an explicit acceptance that a focus on rapid aggregate growth “could produce ‘trickling-up’ and marginalization” (Herring).
Based on these new sets of criteria, while showing stagnant growth on one side, Ceylon was also showing significant improvements in social well-being, especially among the “poorest of the poor” andbeing recognized as a positive development model in the post-1970s literature.
As per the World Bank’s “World Development Report’ 1979, Sri Lanka had a literacy rate of 85% when China’s was 66% and India’s was 36%. GNP Per Capita (1977) showed Sri Lanka at US$200 while India ($150), Pakistan ($190) and Bangladesh ($90) were lower. Sri Lanka also out-performed these nations and many others on Infant Mortality and Life Expectancy rates.
The Physical Quality of Life Index (PQLI) is a composite of literacy, infant mortality and life expectancy; Herring states that “Sri Lanka’s PQLI of 82… came closer to that of Sweden (97) or to the United States (95), than to that of India (42) or Afghanistan (17)”. Around 25% of GOSL expenditures went towards social security and welfare in the mid-1970s, while India and Pakistan were at low single-digit levels (2% and 3% respectively). This is cited as evidence of “relatively effective mediation between national poverty and individual well-being in Sri Lanka… sustained by extensive public intervention in economic processes, with specific politically driven priorities”.
The conclusion follows that the post-independence welfare state, while expensive and administratively complex, was largely successful, especially in relation to other post-colonial nations in the region. Sri Lanka’s structural dependencies on international markets and the commodity-based export mix would consistently leave it vulnerable to external shocks. Perhaps under-performance on growth objectives should be considered in the context of the dependency dynamicas much as on the priorities of expenditure.
As the terms of trade deteriorated throughout the 60s and for much of the 70s, policy became more reactionary and ultimately untenable as JR launched the liberalization program. Sri Lanka by then had a legacy of successful welfare schemes, but also an extensive regulatory framework over production. The liberalization regime had multiple benefits that are well understood but the negative effects must also be emphasized, specificallythecomplexities arising from dependence on international financial flows.
There is a fetishization of the post-1977 liberalization period that perhaps overestimates its economic benefits and under-appreciates the shocks caused by accompanying stresses placed on the poorest segments, and crucially, the restless, under-employed youth. There were investments into welfare projects, especially in the education sector as well as financial assistance to the rural sector, even a food stamps scheme to supplement reductions in the food subsidy.
However, David Dunham and Saman Kelegama for the Institute of Social Studies (1994) note that policy in the 1980s “was preoccupied with infrastructural development” and that the losses to the poor created by ‘stabilization policies’ were not “offset by higher income… the benefits of reform were distributed unequally, heavily concentrated amongst the top 10% of income receivers. The complications of policy throughout the 80s and leading to the 90s were compounded by the political prerequisite to protect the poorest and most vulnerable in Sri Lanka”. This should not be viewed in a negative light; difficult decisions made to serve the greater good are often judged kindly by both historical narratives and analytical scholarship.
Dunham et al conclude that “in Sri Lanka, the factor reallocation costs that accompanied the post-1977 liberalization package resulted in increasing social and regional disparities… dove-tailing liberalization and stabilization measures proved
State Expansion for Political Patronage
Throughout its history, the record suggests that the economic role of government in Sri Lanka has only ever increased, regardless of whether it is a conservative or populist regime. Every administration found that the expansion of government, through nationalizations or otherwise, provided opportunities to reward political patronage.
Patronagealso extends to the private sector, as it has always done. The disconnect between the country’s real economy and the misery of the people versus the corporate profits and record stock market gains, reiterate the growing imbalance in Sri Lanka’s socio-economic equation. A piece by Saman Gunadasa recently highlighted that the country’s top 9 companies amassed Rs. 364 Bn in earnings and Rs. 21 Bn in profits during the previous quarter. Some large financial institutions have grown their net interest incomes by double digits over the previous year’s corresponding quarter, despite the low interest rate regime. It should be a sign of economic prosperity when corporate profits are improving. Yet against the backdrop of food rationing and queues for milk powder, it is clear that there has been no trickle down and still worse, reflects a kind of dystopian future where industry is a priority but subsidized meals for the poor is ‘price distortion’.
Gunadasa points out that many large companies, usually part of conglomerates, remain in operation under the guise of ‘essential services’, yet small businesses and entrepreneurs in those same industries cannot operate due to ‘lock-downs’. The CBSL provided concessionary funds to large corporates including those that reduced executive pay as soon as the initial lockdowns of April 2020 were announced. Meanwhile, corporate taxes are currently amongst the lowest in the South East Asian region at 14%-18%.
Sri Lankan policy must resist the over-correction of introducing an agenda of unrestrained liberalisation. This would be explicit acceptance that the fastest route to some level of financial and economic equilibrium is to embrace the multinational driven model of growth that defined the neo-liberal period which much of the world is nowabandoning. That which is now colloquially known as “Globalism” might risk Sri Lanka’s unique history of safeguards for the poor, one of those structural antiquities that should actually make Sri Lankans proud. Keynesian thinking has ruled Sri Lanka for much of its post-independence period. There most probably is no reconcilingthe country’s policies toprotect the poor and the forces of the invisible hand. The market will never adjudicate trade-offs between the social well-being of the people and the economic indicators of the nation.
Noam Chomsky notes that one of the foundational thinkers of Classical Liberalism, Adam Smith, only mentions this concept of the “invisible hand” once in his work: “The Wealth of Nations”. Smith considered that the free movement of capital and imports would damage the English economy due to the possibility that industry would shift abroad.
However, he countered these concerns with his rationale that British capitalists would rather invest in England due to what is called the ‘home bias’; the result of an invisible hand that would compel them to maintain their capital in England. This is effectively a critique of neo-liberalism. Sri Lanka must not allow its economic policy to be hijacked by corporate interests and market forces, thereby risking the country’s hard-fought history of social welfare that sustain so many who would otherwise be living in abject poverty.
The author can be reached on email firstname.lastname@example.org and Twitter: @kusumw